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Nice theory, but in practice many banks do not actually carry risk, because they are “too big to fail”. LBOs fall in the same category as credit default swaps -

Nice theory, but in practice many banks do not actually carry risk, because they are “too big to fail”. LBOs fall in the same category as credit default swaps - useful in theory, huge moral hazard in our version of a “free market”.

ikeboy 7y ago
If you think the risk of debt is too high, then require banks to be capitalized higher against that kind of debt. Don't ban them from funding certain kinds of debt. There are no banks that failed due to defaults from LBOs. Besides, the plan goes well beyond banks. If a private investor wants to lend money for an LBO, this still prevents it.
- gridlockd 7y ago
  I am not arguing for a ban, nor am I saying that LBOs cannot work. I am saying your bank risk argument in favor only works in theory and therefore we will have for more LBOs that cannot work. Of course LBOs are not significant enough to single-handedly cause a bank to fail. However, they can still cause companies to go bankrupt that would have otherwise survived. In any event, in a system where banks are not allowed to fail, I cannot see how they should be allowed to finance LBOs.
  - ikeboy 7y ago
    >However, they can still cause companies to go bankrupt that would have otherwise survived. If a company's operations aren't profitable, it wouldn't have "otherwise survived". If it is profitable, then bankruptcy will wipe out debt and permit it to continue operations, hence it will continue to survive. It's the difference between Chapter 7 and Chapter 11. >In any event, in a system where banks are not allowed to fail, I cannot see how they should be allowed to finance LBOs. What work is LBO doing in this sentence? Financing LBOs carry some risk of loss, as does everything except Treasuries. Why would LBOs be special as something banks shouldn't be allowed to finance? Why are banks uniquely bad at risk analysis of LBO debt as opposed to, say, regular corporate debt, or junk bonds, etc?
    - gridlockd 7y ago
      > If a company's operations aren't profitable, it wouldn't have "otherwise survived". If it is profitable, then bankruptcy will wipe out debt and permit it to continue operations, hence it will continue to survive. It's the difference between Chapter 7 and Chapter 11. Debt is wiped out after liquidation. Most companies do not survive this. Debt service can make the difference between profitability or unprofitability. Remember, this is debt that was forced on the company externally. > Why are banks uniquely bad at risk analysis of LBO debt as opposed to, say, regular corporate debt, or junk bonds, etc? I never said they are bad at risk analysis, I am saying they do not truly carry the risk in the first place. The difference is in the outcome. An LBO that should never have happened is worse than a corporate loan that should not exist.
      - ikeboy 7y ago
        >Debt is wiped out after liquidation. Nope. I get the feeling you don't know the difference between chapter 7 and chapter 11? >An LBO that should never have happened is worse than a corporate loan that should not exist. Why?
        gridlockd 7y ago
        > I get the feeling you don't know the difference between chapter 7 and chapter 11? Same here. Chapter 11 doesn't "wipe out debt", that's what Chapter 7 does. Chapter 7 implies liquidation. Chapter 11 may reduce debt obligations, entail partial liquidation, and so on. It doesn't just wipe out the debt. > Why? Because of the moral hazard. If I can just get a loan for an LBO to buy a company and squeeze it out like lemon, that's highly destructive. Unlike when issuing a junk bond, I have no real interest in the companies long-term survival. I guess you can make an argument that debt-financed stock buybacks have similar issues, but that's a topic for another day. In the short term, even a bad LBO looks good for both the bank and the PE firm. Meanwhile, the company has a debt burden that paid for nothing but the privilege of having been bought out, likely requiring them to charge higher prices, which is a strong competitive disadvantage. This leads the whole argument of "restructuring companies to be more efficient" ad absurdum.
  - charlesdm 7y ago
    Maybe, but LBOs also offer a way for shareholders to exit. Unless you can sell to a strategic acquirer (which could also be PE, but usually not) there are not a lot of exit options. And who is going to acquire a business just with equity? People don't want to run businesses for ever. Private equity allows them to, in some cases. An unmotivated entrepreneur who is only doing a half assed job after a while will also cause a company to go bankrupt. Better to sell then. Banks generally have sufficient collateral (i.e. from the acquired business) to cover the outstanding principal in the event of a bankruptcy.

ikeboy 7y ago

If you think the risk of debt is too high, then require banks to be capitalized higher against that kind of debt. Don't ban them from funding certain kinds of debt. There are no banks that failed due to defaults from LBOs. Besides, the plan goes well beyond banks. If a private investor wants to lend money for an LBO, this still prevents it.

gridlockd 7y ago
I am not arguing for a ban, nor am I saying that LBOs cannot work. I am saying your bank risk argument in favor only works in theory and therefore we will have for more LBOs that cannot work. Of course LBOs are not significant enough to single-handedly cause a bank to fail. However, they can still cause companies to go bankrupt that would have otherwise survived. In any event, in a system where banks are not allowed to fail, I cannot see how they should be allowed to finance LBOs.
- ikeboy 7y ago
  >However, they can still cause companies to go bankrupt that would have otherwise survived. If a company's operations aren't profitable, it wouldn't have "otherwise survived". If it is profitable, then bankruptcy will wipe out debt and permit it to continue operations, hence it will continue to survive. It's the difference between Chapter 7 and Chapter 11. >In any event, in a system where banks are not allowed to fail, I cannot see how they should be allowed to finance LBOs. What work is LBO doing in this sentence? Financing LBOs carry some risk of loss, as does everything except Treasuries. Why would LBOs be special as something banks shouldn't be allowed to finance? Why are banks uniquely bad at risk analysis of LBO debt as opposed to, say, regular corporate debt, or junk bonds, etc?
  - gridlockd 7y ago
    > If a company's operations aren't profitable, it wouldn't have "otherwise survived". If it is profitable, then bankruptcy will wipe out debt and permit it to continue operations, hence it will continue to survive. It's the difference between Chapter 7 and Chapter 11. Debt is wiped out after liquidation. Most companies do not survive this. Debt service can make the difference between profitability or unprofitability. Remember, this is debt that was forced on the company externally. > Why are banks uniquely bad at risk analysis of LBO debt as opposed to, say, regular corporate debt, or junk bonds, etc? I never said they are bad at risk analysis, I am saying they do not truly carry the risk in the first place. The difference is in the outcome. An LBO that should never have happened is worse than a corporate loan that should not exist.
    - ikeboy 7y ago
      >Debt is wiped out after liquidation. Nope. I get the feeling you don't know the difference between chapter 7 and chapter 11? >An LBO that should never have happened is worse than a corporate loan that should not exist. Why?
      - gridlockd 7y ago
        > I get the feeling you don't know the difference between chapter 7 and chapter 11? Same here. Chapter 11 doesn't "wipe out debt", that's what Chapter 7 does. Chapter 7 implies liquidation. Chapter 11 may reduce debt obligations, entail partial liquidation, and so on. It doesn't just wipe out the debt. > Why? Because of the moral hazard. If I can just get a loan for an LBO to buy a company and squeeze it out like lemon, that's highly destructive. Unlike when issuing a junk bond, I have no real interest in the companies long-term survival. I guess you can make an argument that debt-financed stock buybacks have similar issues, but that's a topic for another day. In the short term, even a bad LBO looks good for both the bank and the PE firm. Meanwhile, the company has a debt burden that paid for nothing but the privilege of having been bought out, likely requiring them to charge higher prices, which is a strong competitive disadvantage. This leads the whole argument of "restructuring companies to be more efficient" ad absurdum.
- charlesdm 7y ago
  Maybe, but LBOs also offer a way for shareholders to exit. Unless you can sell to a strategic acquirer (which could also be PE, but usually not) there are not a lot of exit options. And who is going to acquire a business just with equity? People don't want to run businesses for ever. Private equity allows them to, in some cases. An unmotivated entrepreneur who is only doing a half assed job after a while will also cause a company to go bankrupt. Better to sell then. Banks generally have sufficient collateral (i.e. from the acquired business) to cover the outstanding principal in the event of a bankruptcy.